In the past allocations to emerging markets were largely determined by capital inflows into China. But in the wake of the Covid-19 pandemic, geopolitical fragmentation, the crackdown on technology companies and the real estate-related challenges in China, many investors, particularly in the US, have reconsidered their exposure.
Europeans have taken a more pragmatic approach, but have nevertheless reduced their exposure.
The outflows from Chinese equities were partially offset by India and a few other countries, but not entirely. At the end of 2020, for example, China’s weight in the MSCI ACWI index was almost 5 per cent, while India’s was around 1.2 per cent. At the end of last year, China was 2.5 per cent, while India climbed to 1.9 per cent.
India’s increased weight is also due to its stellar performance, as the government’s structural reforms are beginning to bear fruit and the country is becoming an increasingly important player on the global stage – both politically and economically.
We are also starting to see renewed interest in China.
Large and targeted stimulus packages in the second half of 2024 have bolstered investor confidence, and the recent release of DeepSeek has firmly established China in the global AI race.
So, we have seen investors maintain strategic exposure to emerging market equities, but within that space there have been significant shifts in recent years.
There is also a growing awareness that these markets require a differentiated approach, so the topic of ‘disaggregation’ – looking at individual countries instead of emerging markets as a whole – has become much more important, as have strategies outside China, for example in the form of exchange-traded funds.
These do not necessarily reflect a negative view of China, but rather the realisation that China is important enough as an economy to justify a separate allocation. This can also help investors better manage the country’s distinct profile.
Opportunities within the diverse EM group
Strategically, we remain convinced about India. Markets have corrected recently and valuations have weakened considerably.
They are now around or slightly below long-term averages.
The country’s strong demographic profile, government reforms and technological innovation are hard to find elsewhere, especially not in this combination. Preferred sectors are consumer goods and financials.
The latter are needed to support the rapid growth and will benefit from it. However, the Indian investment market is not that big.
Of the thousands of listed companies, only a few hundred are really relevant.
So investors should not take too narrow an approach either, in order to remain diversified and really cover all aspects of the market’s many layered opportunities.
China is interesting from a valuation perspective, and we are constructive. But investors need to be able to stomach the volatility.
The government stimulus is encouraging, but we need to monitor the situation to ensure that the economy is indeed back at the top of the government’s agenda.
The market will want to see more support. And we still expect a flare-up of volatility in both the real estate sector and due to geopolitical tensions with the west.
The technology opportunities are considerable, but the sector also presents unique risks due to its sensitivity to national security and US sanctions.
Again, investors with a broad approach can diversify their risks and participate in the potential turnaround of the economy as a whole without being overly exposed to any one sector.
Taiwan and Korea
We are positive on both Taiwan and Korea, but for different reasons.
Taiwan is already a major beneficiary of the AI theme. TSMC is currently one of the only companies capable of producing AI-enabled chips, which are being commissioned by the major US semiconductor manufacturers such as Nvidia.
We expect this trend to continue to drive markets globally and Taiwan to benefit.
Korea has lost some competitiveness in this area and has performed quite poorly.
We see this as a potential turnaround story.
If it can catch up technologically or its consumer electronics market picks up, it is well positioned.
Since both Taiwan and Korea occupy key elements of the global technology supply chain, we also expect that they will be relatively unaffected by US trade policy despite their heavy reliance on exports.
The impact of possible tariffs
Every market can be affected to some extent, but the metrics to look at are the size of the trade surplus with the US, the share of exports in GDP and where the market is positioned in terms of products.
Mexico is clearly vulnerable.
About 40 per cent of its GDP is based on exports, and mainly on raw materials, assemblies and components.
These are of less strategic importance to the US, so Mexico’s leverage is minimal.
Canada is also very vulnerable, but less so than Mexico. Its vast oil reserves give it an advantage in any negotiations.
Next in line is the EU, and particularly Germany, with a large trade surplus.
But despite its weak growth, the EU’s size and population make it a formidable market, so it can offer significant resistance.
China will also be affected, not only because it has a large trade surplus with the US, but also because it is seen as a strategic competitor.
So it is a multi-faceted problem. But we saw during Donald Trump’s first presidency that the countries had found a working relationship before Covid completely broke the bonds.
Finally, we think India is in a strong position.
There is a personal relationship between Prime Minister Narendra Modi and Trump; India has already reduced tariffs to stay ahead of developments; and much of India’s growth is driven by the domestic market.
Exports are growing and are important, but not the decisive factor for the economy.
Marcus Weyerer is director of ETF Investment Strategy EMEA at Franklin Templeton